Financial accounting 10th pratt peters chapter 08

Chapter 8: Investments in Equity Securities Learning Objective Describe what an equity investment is and the criteria used to determine whether investments in securities should be classified as current or noncurrent on the balance sheet What is an Equity Investment? • An equity investment occurs when one company purchases another company’s outstanding common stock • • To earn investment income • • • Smaller and/or short-term investments Dividends Price appreciation To exert influence or control over the board of directors and management • Larger and/or long-term investments Equity Securities Classified as Current Two criteria must be met for an investment in a security to be considered current and thus warrant inclusion as a current asset: The investment must be readily marketable Management must intend to convert the investment into cash within the time period of current assets (one year or the operating cycle, whichever is longer) Concept Practice Learning Objective Describe mark-to-market accounting and how it is applied to passive investments in equity securities Passive Investment in Equity Securities Companies may purchase equity securities in small amounts to earn investment income and not exert influence These are passive investments • Passive investments use the mark-to-market rule • • Assets are carried at their current market value Changes in value of securities are recorded as income or loss on the income statement Purchasing Passive Investments in Equity Securities • • • Capitalized and recorded on the balance sheet at cost Cost includes purchase price plus incidental acquisition costs Assuming the security is readily marketable and the equity amount is small the journal entry is: Short-Term Equity Investment (+A) Cash (-A) XXX XXX Purchase passive equity securities Declaration and Receipt of Cash Dividends • The company has a legal right to declared dividends as a shareholder A receivable and revenue are recorded Dividend Receivable (+A) Dividend Revenue (R, +RE) • XXX XXX Recognized declaration of dividend When Cash is received, the receivable is exchanged for cash Cash (+A) Dividend Receivable (-A) XXX XXX Received cash dividend 10 Learning Objective Describe a business acquisition, define goodwill, and explain its accounting treatment 25 Business Acquisition, Mergers, and Consolidated Financial Statements • • A business acquisition occurs when an investor company acquires a controlling interest (more than 50 percent of the voting stock) in another company If the two companies continue as separate legal entities, the investor company is referred to as the parent company, and the investee company is called the subsidiary • • Consolidated financial statements should be prepared A merger, or business combination, occurs when two or more companies combine to form a single legal entity 26 Goodwill Goodwill is a noncurrent intangible asset created when a company pays an amount to acquire a controlling interest of another company that is more than the fair market value of net assets Figure 8-4 Computation of goodwill 27 Equity Method or Consolidated Statements? The user needs to understand the effect of the different presentations on the financial statements Figure 8-5 The balance sheets of Megabucks and Tiny Inc 28 Equity Method or Consolidated Statements? Figure 8-6 Consolidated balance sheet Consolidating the financial statements can weaken a company’s ratios, especially when the subsidiary has considerable debt This has encouraged companies to use the equity method when possible and avoid ‘control’ 29 Special Purpose Entities (SPEs) •Companies often create separate entities to carry out activities or transactions directly related to specific purposes The entities (called special purpose entities or special purpose vehicles) take on various legal forms •The key accounting question related to SPEs is whether the sponsoring company (e.g., Company A) should include (consolidate) the financial statements of the SPE with its own financial statements • • Retain control – consolidate Relinquish control – no reason to consolidate 30 Accounting for Equity Investments: A Summary Figure 8-8 Accounting for equity securities 31 Concept Practice 32 Learning Objective Appendix 8A Describe the acquisition method of accounting for business acquisitions 33 Accounting for Acquisitions and Mergers: The Purchase Method *Appendix 8A Figure 8A-1 Balance sheets for Multi Corporation And Littleton Company (before acquisition) 34 Accounting for Acquisitions and Mergers: The Purchase Method *Appendix 8A 35 Case : Purchase 100% of Stock at a Price Greater than the Per-Share Market Value of the Net Assets *Appendix 8A 36 Case : Purchase 100% of Stock at a Price Greater than the Per-Share Market Value of the Net Assets *Appendix 8A 37 Case : Purchase Between 50 and 100 Percent of Stock at a Price Greater than the Per-Share Market Value of the Net Assets *Appendix 8A 38 Case : Purchase Between 50 and 100 Percent of Stock at a Price Greater than the Per-Share Market Value of the Net Assets *Appendix 8A 39 ... forms •The key accounting question related to SPEs is whether the sponsoring company (e.g., Company A) should include (consolidate) the financial statements of the SPE with its own financial statements... +SE) 256,000 208, 000 48,000 14 Concept Practice 15 Concept Practice (cont.) 16 Learning Objective Explain why companies enter into long-term equity investments and describe the accounting treatments... control operations Acquisitions are common for large U.S companies 18 Accounting for Long-Term Equity Investments Figure 8-1 Accounting for long-term investment in equity securities 19 The Equity